Central Banks Will Go Cashless
They just don’t know it yet
Here comes an unpopular opinion. Bitcoin, Ethereum, Ripple and the rest will soon be dwarfed in size by digital currencies issued by governments.
Don’t shoot me for saying it! At least let me lay out my case.
But we need to get one definition out of the way first. A “Central Bank Digital Currency” is an electronic form of Cash. As in Banknotes — the paper stuff printed by the government that denominates your tax bill (which you choose to either pay or go to prison). A working example of this doesn’t exist now, anywhere — but it will.
For simplicity, I’m going to use the term “Digital Fiat” — but you’ll know what I mean.
The Monetary System Of The Future: Why Not Bitcoin?
The first form of digital money is resilient, can’t be printed or debased, shutdown or confiscated and is semi-anonymous.
Why not then Bitcoin?
Well, for a start, governments are unenthusiastic about alternatives to their own money. Real unenthusiastic. It means people cheating on their taxes and black-market double-dealing. Also, it threatens their favorite thing: printing banknotes for free.
You could overthrow the government — but even then ‘Bitcoin as coin of the realm’ wouldn’t work. The price would be super volatile due to something called inelastic supply (you can’t produce the stuff quick enough for demand). Whoever was in charge after the revolution would have no monetary policy. That means no control over inflation — no brake or accelerator to control the economy.
Of course, it’s possible Bitcoin becomes the worlds reserve currency. But governments won’t do it by choice.
Online Banking Money Is Not Real Money!
Haven’t we already got digital cash? We do, sort of — internet banking is super convenient. But numbers on our online bank statement are not the same as numbers on the grubby notes in our pocket. That’s why old people jam cash under the mattress. They know its proper money backed by the state — the central bank even signs the paper, so you know!
Bank statements show what the bank says it owes you. This is a type of “I owe you” switchable for banknotes only if you get to the branch on Monday before it goes bust on Tuesday. Yes, there are deposit guarantees and so on — but you get the idea. Your mortgage? Same thing but in reverse: a liability you owe the bank, not the government.
Commercial banks sit in the middle. Between you and the government. They have a special license allowing them to lend more money than they actually have. Have $1 in the vault? Lend out $10 to bank customers. This magic is “fractional reserve lending” or “credit creation”. It gets money moving around the economy like oil round a car engine. It works pretty well. Until the economy seizes up and the public starts to look at the magical one in, ten out sideshow and begins to worry. And then bank runs are what happens.
Digital Fiat: The ‘Real Deal’
But what if we could deposit and withdraw money using an account with the central bank?
What if we cut the commercial banks out of the game?
This is what Digital Fiat allows. There are a couple of ways we could hold central bank money. In an account, as we do with our commercial bank. Or be our own bank using an electronic wallet a `la Bitcoin.
As a member of the public, it would be reasonable to ask:
“Why would I want central bank money?”
The answer is you wouldn’t — not really. You might sleep easier knowing you were safe from bank runs. But even in the great crisis of 2008 no depositors lost savings thanks to bailouts. No, the real motivation for Digital Fiat will be political. And it will come from the opportunity for tighter state control over a bunch of things. Stay with me here, as I walk you through them.
Reason 1: Financial Risk
By now everybody from supermarket cashiers to Yupik Eskimos has heard of the financial crisis:
They know who caused it as well: greedy bankers taking massive risks with other people’s money. But despite reducing risky lending ratios (remember the fractional reserve magic with the $1->$10?) the system is still broken. When you can bet with other people’s money it makes sense to bet big, and bet often. There’s no avoiding the fact the partnership between central and commercial banks is inherently unstable.
This will persist if the government keeps current financial regulation and incentives. A decade on from the crisis the behaviors are the same. If we deposit cash in a bank branch the bankers have started betting with it before we’ve got as far as the door.
Digital Fiat is different — money gets deposited in the central bank directly. It gets nowhere near a bad banker, and it has no chance to turn itself into risky liabilities. So far so good.
The problem is when we need a mortgage we go to the commercial bank to borrow the money. Critics claim it (the commercial bank) won’t then have the money. It can’t lend it out as people like us are no longer depositing our savings into it. Do you see the chicken and egg problem? The argument then goes the bank will then have to raise interest rates to attract deposits and its profitability will suffer.
For a start, this doesn’t make sense. Banks don’t need to be funded from deposits — they can issue bonds or borrow funds from the central bank. It also doesn’t explain why we should lose any sleep over commercial bank profitability. Why can’t they just suck it up and adapt their business models?
Central bank bosses have offered nonsensical arguments against Digital Fiat. Concerns it would cause central banks to compete with high street banks or increase the risk of bank runs.
In the first case, the provision of a simple digital payment account shouldn’t pose an existential threat to high street banks. No one is suggesting the central bank provide a branch network complete with blazered sales staff.
Retail banks will continue to provide services but they’ll need new business models. And let’s get something straight. “Free banking” has never been free. It has relied on monopoly profits.
As for bank runs — the alleged problem is the ability to swap risky commercial bank deposits for safe central bank ones. Of particular concern is that during a crisis we might actually choose to do so. Of all the counter-intuitive points this is the silliest. We should prevent the public from acting in their best interests by locking their funds in a stricken banking system?
The arguments about financial contagion are the wrong way around.
Giving the public access to safe, digital currency within central bank accounts actually reduces risk. Why? Because commercial banks will have to get capital priced properly, not backstopped by a “too big to fail” subsidy. Governments are going to join the dots.
Reason 2: Money And Interest Rates
During economic busts people stop spending money, making the downturn worse. To get things moving central banks cut interest rates. But what are the options once rates get down to zero percent? Not much — you can’t discourage people from holding cash.
Unless of course, that cash is digital. In that case, you can use something called “negative interest rates”. This applies a penalty — encouraging the money out of your (digital) pocket and back into the system.
To be clear, central bankers would love to do this. But some also agonize over what depositors would do if they had easy access to a riskless asset. In this case, the concern is how it would mess up their careful management of the monetary policy.
This is a short sighted.
There is no common agreement Digital Fiat would cause these problems. The IMF suggests all four channels of monetary policy transmission would be either unaffected or improved.
Digital Fiat is good news for policymakers. Monetary policy has always has been an imprecise business. You have the base interest rate. Then you have a system of levers and pulleys called open market operations and a ton of guesswork. No one knows exactly how much money there is out there and where it is.
But imagine complete oversight over what money is outstanding. Imagine knowing who owns it, whether banks have re-lent it and the exact speed it is moving through the system. This last measure (velocity of circulation) makes accurate inflation targeting possible.
Digital Fiat is the gateway to the precision monetary policy. It’s something that should make central bankers pretty excited.
Reason 3: Anonymity, Tax, And Bad Guys
Here’s another reason we end up with Digital Fiat.
Untracked money is a pain for the taxman, who either can’t identify taxable activity or collect the tax due on it. Physical cash is the worst of the lot — it’s completely anonymous. Governments are trying to get rid of it, particularly high denomination bills.
This may be why IMF’s Christine Lagarde makes the case for Digital Fiat. Lagarde proposes a semi-anonymous digital currency. One where anti money laundering and terrorist financing controls would run in the background.
She goes on to suggest authorities could “lift the veil of anonymity” under certain circumstances. Hmm.
It’s all quite feasible as well. Cryptographic technology provides many ways to preserve anonymity while providing a backdoor for authorities chasing bad guys. The problem is what else this enables. How do you feel about 24–7 tax surveillance? And all this could be added onto Digital Fiat years after the public agreed to something much less spooky.
The IMF is currently cheered leading Digital Fiat citing “financial inclusion”. Is it possible they have their mind on something else?
Why Is This Inevitable?
There’s currently widespread suspicion of Digital Fiat.
Central banks either don’t understand it or don’t want to bear the risks of its implementation. Commercial bankers horrified of the threat to their business model will certainly lobby against it.
Why then is it inevitable?
Because it delivers a bunch of stuff governments really want — even if they don’t realize it yet. Digital Fiat means a more stable financial system. It improves control over the boom and bust of economic cycles. It offers oversight that increases the cost of criminality and tax dodging.
Bankers objections arise from either ignorance or an interest in protecting the broken but lucrative status quo. Commercial banks have grown fat on the monopoly profits of licensed credit creation. The sky will not fall in if they must find other sources of funding, or charge for banking services, or innovate for the first time in decades. And supportive noises are coming from the independent sources: the IMF, working groups and the BOE.
I’m pretty certain Digital Fiat is coming.
As I said at the beginning — don’t shoot me for laying out the case. If anything, this article is more warning than endorsement — plenty of people won’t like the idea of it. But be aware — ahead we have a workable technology and one that offers the perfect cocktail of economic management and state surveillance.
For how long do you think Governments will ignore it?
